Why TFSAs are a top choice in estate planning
"There's so much flexibility from an estate-planning standpoint."
For all of the investment accounts and tax strategies out there to shield your life's wealth from the tax man upon your death, one of the most popular options among finance experts to shelter assets from estate taxes is actually a tool many Canadians already own: the Tax-Free Savings Account (TFSA).
"Even at your death, it won't have tax. It's a pure tax-free account," Sylvia Azoulay, vice-president of tax and estate planning at Richardson Wealth, told Yahoo Finance Canada by phone.
"You want to maximize the amount you can contribute."
At the time of death, there is no tax on your TFSA.
If the spouse is designated as the successor, it will automatically roll over to the holder's spouse, free of tax, regardless if the spouse has enough contribution room or not. Upon the spouse's death, the fair market value of the account is transferred to their estate or a beneficiary, tax free.
There's so much flexibility from an estate-planning standpoint.Frank Gasper, CSR Wealth Management
If there's no spouse, the TFSA holder can name a beneficiary and the tax-free advantage still applies.
Contrast this to Registered Retirement Savings Plans (RRSPs). All of the money in an RRSP will be taxed in the account holder's hands upon death, which could result in a massive tax hit for family members.
If the spouse is named as a beneficiary on the account, it will be rolled over to them and the tax will not be immediately owed. However, it's important to note that taxes will need to be paid whenever there are withdrawals made from the account or when the surviving spouse passes away.
This is one of the reasons Frank Gasper, a wealth advisor and the founder of CSR Wealth Management, also touts TFSAs as a fantastic estate planning tool.
"There's just no downside," he said. "There's so much flexibility from an estate-planning standpoint."
Upon death, a deemed disposition is triggered on the person's assets, meaning it's as if all of their assets were sold at fair market value right before their passing, potentially resulting in a significant tax bill for family members to deal with.
Using built-in measures within the government and tax system, such as tax exemptions and successor rules, as well as some additional financial planning strategies can help protect assets from being taxed and leave more money for family members.
Life insurance as an investment
It's not as prominent as the usual suspects such as an RRSP, TFSA or stock brokerage account, but life insurance policies can also be used as an investment tool, with the added benefit of allowing the investments to grow tax free.
"You can use life insurance as an additional investment asset class," Azoulay said.
"If you have money that you know you're not going to need for yourself, you can invest in a life insurance policy, and that's going to pay out tax free at your death to your heirs."
Segregated funds are also sometimes used in estate planning. They are essentially mutual funds with a life insurance element. They can protect against market declines since they guarantee 75 per cent to 100 per cent of the original money invested and can bypass probate fees since they have named beneficiaries.
However, Gasper, who is also a life insurance agent, says segregated fund fees are higher than other investments, so he's "not a big believer" in them.
There are certain situations where they can make sense for a client, but it's rare, he says.
Real estate in estate planning
When it comes to real estate, most Canadians are familiar with the principal residence exemption which allows the family residence to be sold tax free.
For married couples, the marital home is often owned as a joint tenancy, meaning the property is owned by both parties. Azoulay says this allows the home to seamlessly pass to the surviving spouse upon the other's death, and bypass probate fees.
Minimizing estate taxes when secondary properties such as a cottage or vacation property are involved can be much more difficult. However, one benefit of the principal residence exemption is it can be split between multiple properties, not just the main family home.
If one property had a bigger gain in value than the other, the exemption can be applied to shield the gain. It involves some math and research, Azoulay says, but it can lower an individual's overall tax burden.
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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